In late 2017 congress finalized the Tax Cuts and Jobs Act (TCJA) which was effective beginning in January 2018. There were a number of changes to both corporate and personal income tax rules. A number of these tax laws have a sunset provision that is due to expire beginning 2026. Let’s take a look at a summary of the changes related to individual tax law changes.
Individual Marginal Tax Rates
The individual marginal tax brackets were seven separate brackets which were progressive in how they were applied ranging from 10% to 39.6%. Beginning in 2018, there are now seven brackets ranging from 10%, 12%, 22%, 24%, 32%, 35% & 37%, which are still applied progressively. However, there are a number of changes in how those brackets will be applied and at what income thresholds. In some cases, this can result in higher wage earners reaching a higher marginal bracket much faster due to their single filing status.
As an example, in 2017 all taxpayers (other than those filing “Married Filing Separately”) became subject to the 35% bracket at the same level of taxable income ($416,700). Beginning in 2018, the 2nd highest bracket may now apply based upon filing status. In 2018, unmarried taxpayers will have the same 35% bracket apply once taxable income exceeds just $200,000 rather than what was $416,700. Yet, joint filers will have the 35% bracket apply at a reduced level of $400,000 and married separate filers will have the 35% bracket apply once taxable income exceeds $200,000.
Trusts and Estates
Beginning in 2018, trusts and estate tax rates will be subject to four tax brackets (10%, 24%, 35% and 37%) with the highest bracket applying for 2018 to taxable income in excess of just $12,500.
The tax rates on capital gains remained unchanged with the thresholds for capital gains now being applied based on the following income tiers.
Rate Single Married Joint Head of Household Trust & Estates
|0%||$0 – 38,600||$0 – $77,200||$0 – $51,700||$0 – $2,600
|15%||$38,601 – $425,800||$77,201 – $479,000||$51,701 – $452,400||$2,601 – $12,700
|20%||Over $425,800||Over $479,000||Over $452,400||Over $12,700|
One of the biggest changes relating to the TCJA is the increased standard deduction. As a result of this new standard deduction, many more Americans, particularly those with little debt will no longer need or want to itemize their deductions. The new base standard deduction is $24,000 for married taxpayers filing joint returns, $18,000 for taxpayers filing as Head of Household and $12,000 for all other taxpayers for 2018. Married couples over age 65 will receive an additional $1,300 each. Single filers over age 65 receive an additional $1,600. This deduction will also be adjusted for inflation after 2018. It should be noted that along with this increased standard deduction, the personal exemption is suspended until the year 2026.
Alternative Minimum Tax
The often dreaded AMT was NOT eliminated by the TCJA. However, there were some changes pertaining to the AMT. Beginning in 2018, the exemption amounts have been increased to $109,400 for joint filers ($54,700 for separate filers), $70,300 for unmarried taxpayers and $24,600 for estates and trusts.
Beginning in 2018, for those who continue to itemize their deductions, a number of itemized deductions have been eliminated:
- All expenses related to tax return preparation;
- All unreimbursed employee business expenses;
- Appraisal fees for charitable contributions;
- Investment expenses;
- Union dues.
Qualified Residence Interest (Mortgage Interest & Home Equity Loans)
Prior to 2018, the deduction for Qualified Residence Interest was limited to interest paid on up to $1,000,000 of borrowing that qualified as “Acquisition Indebtedness” (Mortgages up to 1 million) and up to $100,000 of borrowing that qualified as “Home Equity Indebtedness” (Home Equity Loans).
Prior to 2018, Acquisition Indebtedness was defined as debt incurred to acquire, construct or substantially improve a principal residence or a second home.
Home Equity Indebtedness included any borrowing secured by a principal residence or second home, with no restriction as to the use.
Beginning in 2018, the amount of eligible Acquisition Indebtedness borrowing is reduced to $750,000 for any debt incurred on or after December 15, 2017.
So moving forward in order for mortgage interest to remain deductible, the mortgage cannot exceed the cap of $750,000. There was some confusion around the use of home equity loans as a deduction, as the tax law eliminated the deduction of Home Equity Indebtedness. However, The IRS, in early 2018, issued an Information Release to clarify the difference between the Internal Revenue Code definition of Home Equity Indebtedness and the use of the term “Home Equity” by banks in describing or naming the loans they are making. The release made it clear that regardless of what terminology a bank uses to describe a loan, if it is used for “acquisition, construction or substantial improvement” then it can qualify as Acquisition Indebtedness (subject to the dollar limitations). Essentially, this means that home equity interest payments remain deductible in many cases, so long as it is used for the above criteria.
State and Local Taxes (SALT Deductions)
One of the least popular areas of the tax code, particularly for those that live in high tax states is the reduction of the SALT deduction. Prior to 2018, what was paid in SALT was listed as a deduction on your Federal income tax return. Beginning in 2018 this amount is capped at an aggregate of $10,000 per return. This means that whether you are a married or single filer the total is $10,000. There was some initial confusion as many taxpayers thought this applied only to their property taxes. In reality this is on ALL State and Local taxes paid. So a high earner in a high taxed state like New York or California may have exhausted their entire deduction via the State income taxes paid, rendering their entire property tax bill non-deductible beginning in 2018. Those individuals who earn lower wages or reside in states with no State income tax may not be negatively affected at all.
Child Tax Credit
Prior to 2018, a taxpayer could claim a child tax credit of up to $1,000 per qualifying child under the age of 17. This amount was phased out by $50 for every $1,000 that the taxpayer’s AGI exceeded certain threshold amounts.
Beginning in 2018, the child tax credit is increased to $2,000 per eligible child. The income level at which the credit phase-out begins is increased to $400,000 for taxpayers filing married filing jointly and $200,000 for all others. The credit continues to phase out at a rate of $50 for every $1,000 that AGI exceeds the threshold amounts.
There were some fairly significant changes pertaining to alimony. In prior years, the recipient receiving the alimony payments might need to report that payment as taxable income, and the paying spouse could deduct that payment made to their ex-spouse. Beginning in 2019 (not 2018), alimony payments are no longer deductible on any divorce agreement executed after December 31st 2018. Additionally, such payments are no longer taxable to the recipient.
529 College Savings Plans
There was one significant change pertaining to 529 plans. Under prior law, in order for 529 distributions to be treated as tax free, qualified expenses required the student to be enrolled at least half-time in a college, university, vocational or other post-secondary school.
Beginning in 2018, qualified expenses include tuition at an elementary or secondary public, private or religious school (along with various expenses related to home-schooling) up to a $10,000 per-student, per-year.
Pass-Through Entity Deduction
One of the most significant changes imposed by the Tax Cuts and Jobs Act is the creation of the new “Qualified Business Income” deduction. Pass-Through entities are typically small business established in various forms such as S-Corp’s, LLC’s, LLP’s, etc. These entities pay tax at the ordinary income tax rates as all of the income from business profits pass-through to their personal tax return.
As per the TCJA, non-corporate taxpayers (including trusts and estates) that have Qualified Business Income (“QBI”) from a partnership, S Corporation or sole proprietorship can take a deduction of up to 20% of the QBI. QBI is generally defined as the net amount of income, gain, deduction and loss relating to a qualified trade or business and effectively connected to the conduct of the trade or business within the United States.
For pass-through income from a service business, a limitation phases in when the owner’s taxable income (from all sources) exceeds $157,500 for single taxpayers and $315,000 for married taxpayers filing joint returns and is completely phased-out when taxable income exceeds $207,500 and $415,000 respectively.
Certain types of income are specifically excluded from being treated as QBI, and therefore not eligible for the deduction. Investment income along with reasonable compensation payments, guaranteed payment to a partner for services rendered and payments for services to partners not acting in their capacity as partners are not included.
A limitation is imposed on income from certain specified service businesses, including businesses that perform services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, trading or dealing with securities and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.
Self-employed individuals that are organized as a pass-through should inquire with their tax advisor to see if they will benefit from this 20% deduction.
Another significant change to estate planning strategies is the increased estate exclusion. For 2018 the new exclusion is $11,200,000, adjusted for inflation annually. Utilizing proper planning techniques, that figure can be doubled for a couple. This makes the risk of being impacted by the estate tax much less significant for most Americans. However, depending on the state in which you live there may be additional estate or inheritance taxes that may still require a degree of more sophisticated planning. It is still wise to consult with an experienced estate planning attorney in your local area.
There were many changes to the tax code not covered in this summary, and a number of these modifications referenced are set to expire beginning 2026. The tax code is something that is inherently complex, and it is often wise to make sure you are consulting a qualified tax advisor that can also work in tandem with your attorney and/or your financial planner to insure that you are utilizing the proper planning techniques.